AM Whitepaper

The 2019 Construction Payment Report, produced by Levelset and TSheets by Quickbooks, is based on a survey of 500 construction professionals.

• Nearly 50% of contractors deal with retainage in excess of 10%.
• More than 40% of the respondents make payments to subs, suppliers and laborers before they are paid by the hiring party.
• Only 4% of respondents always get paid deposits upfront for work.
• 23% of contractors said it takes over 2 weeks to recover after a cash flow problem. (26% said it takes more than a month!)
• More than 58% of contractors surveyed have filed a mechanics lien to get paid.

Slow Payment Stresses Cash Flow

In the construction industry, it takes 83+ days to get paid on average. This delay makes it more difficult for contractors to make projections, plan for new projects, manage AR and AP, and pay for labor or supplies.

Deposit-less

Once used to pay suppliers and staff before the first progress payment comes in, deposits have now all but dried up in the construction industry. Only 4% of contractors say they receive up-front deposits on projects. At the same time, 42% of contractors say they pay their suppliers before they get paid themselves. This means accountants will need to help the contractor plan for an immediate outflow of cash on a project. How to help: Give the contractor an accurate picture of their cash outflow during the first several months of a project before the first progress payment comes in. Possible solution: Encourage the contractor to ask the GC or owner to pay supplier invoices directly, so they aren’t drawing down their cash reserves or relying on interest-bearing loans to meet material expenses early on.

Retainage

The stress doesn’t end when the project finished, however. In the survey, 57% of contractors say a percentage of their full payment is “always” or “sometimes” withheld as retainage (also known as “retention”). A practice unique to the construction industry, retainage is money withheld by the GC or property owner — typically 5-10% — until the entire project is finished. Contractors often have to wait until months, or even years, to recover the retainage. With profit margins in the industry averaging under 5%, it means that some businesses may be operating in the red until they get the retainage payment. Construction accountants can help prepare their clients for this scenario ahead of time. Contractors will need to have enough cash on hand, or have access to credit that can help them through periods of negative cash flow. How to help: If waiting for retainage will cripple a contractor’s cash flow, they can try to secure a retention bond to avoid withholding by the GC. The contractor will need to make the premium payments, so this option may only make sense on bigger projects where retainage makes up a significant portion of their cash flow. Possible solution: Encourage the contractor to ask for better retainage terms in their contract. That might be a lower retainage rate overall. Or they can request variable retainage, where the rate is reduced after a certain percentage of the project is complete. If the contractor has a history with the GC, ask for retainage to be waived.

Lenient with Late Payers

Part of the reason construction payments keep getting slower and slower may be that there are few, if any, repercussions for higher ups on a project. In the survey, 78% of contractors say they “rarely or never” charge interest on late payments. More than half actually give discounts to late payers in an effort to get anything at all. At the same time, contractors rely heavily on credit lines to meet expenses while they wait for payment. In the survey, 51% of respondents said they use business credit or savings to pay their bills. Even more worrisome, 34% said they use personal credit cards or savings accounts. How to help: Ensure the contractor understands the full carrying cost of late payments. If they are using credit cards to make it through a project, but aren’t taking interest payments into consideration when costing a job, they could find themselves underwater financially. Understanding the full cost profile of a job — including what it costs them to wait for payment — will help them estimate project costs more accurately.

Contractor Offense Needs Accounting Defense

Contractors don’t get into the construction industry to start a credit business. They want to get paid as smoothly as possible on each project, so they can move onto the next one and continue to build their business. However, a culture of slow, late payments cause many contractors to run into cash flow problems that derail their progress or, worse, put them out of business. As long as they have protected their rights during the project, contractors generally have a last line of attack to get paid: Filing a mechanics lien. And attack, they do. According to the survey, nearly all contractors and suppliers have threatened to file a lien (98%) and more than half have actually filed one (58%) in order to get paid. Construction accountants can help contractors deal with slow payments in a number of ways. They can help the contractor get a more accurate picture of the cash they need early on in a project without a deposit. Accountants can provide information on the carrying cost of late payments that helps the contractor estimate jobs more accurately. A good construction accountant understands the variety of payment challenges that contractors face in order to defend project managers’ and supervisors’ access to their lifeblood: The cash needed to buy materials and pay the workers to complete their project on time, and under budget. Thanks to Justin Gitelman for sharing the whitepaper focused on the impact that slow paying clients can have on a construction company and how we, as accountants, can help. Reach out to Justin to learn more!  " target="_blank">Contractors Don’t Get Paid on Time. How Can Accountants Help?

Philadelphia Business Journal, some 70 percent of family-owned businesses fail or are sold before the second generation gets a chance to take over. While many owners prefer to pass the business on to family or staff, the failed transition is often due to a lack of trust and communication between the owners and successors, and the successors not being adequately trained with the right management skills. There are various types of business transition methods, and the following are the most popular in the construction industry:

• Internal sale. The company, under the new ownership structure and management team, secures funding from a bank in order to buy out the current owners, or the existing owners provide self-financing of the transaction.
• External sale. An external (third-party) sale is typically the best opportunity for the company’s shareholders to maximize value and liquidity while minimizing deal risk. However, the external sale creates the most exposure to future change.
• Recapitalization. The current owners identify a financial partner who is willing to acquire a majority of the stake in the company. The financial partner typically invests heavily in the company and ultimately seeks a premium with a three- to five-year exit window.
• Employee stock ownership plan (ESOP). An ESOP trust is formed in order to acquire stock from the selling owners in exchange for liquidity. Shares are then allocated over time to the accounts of eligible employees based on various factors. The ESOP offers the opportunity to create significant tax savings to the selling shareholders as well as to the company, if the company makes an S corporation election.
• Old company and new company plan. The old company ceases to build up value and essentially ceases its operations while the new company finishes out the work of the old company under a project completion agreement. The old company guarantees the bank debt and bonding line of the new company for a period of time so the new company can establish its financial strength. After a period of time, the old company is liquidated.

Formulate a Plan

Open communication is vital to any succession plan. Start the process by talking to family and staff who can objectively discuss your vision for the future — for yourself and your company. Once you have shared your ideas you can formulate a plan by focusing on the following steps:

1. Identify financial conflicts:
   • Expected versus real value of your company
   • Personal needs after retiring
   • Management’s acceptance of risks associated with a change in ownership
   • Credit capacity of the company, and impact on ongoing operations after the transition
2. Decide which family and/or key manager(s) you want to be part of your ownership and management succession plan.
3. Make sure your key players understand the responsibilities and risks associated with their role in the succession plan. Alignment of all stakeholders regardless of their role is essential for your vision to be realized.
4. Evaluate your successor owner/manager’s dynamics in anticipation of how he/she will respond to a change in management.
5. Assess the near and long-term development needs of the company.

Valuation & Financial Reporting

Key factors to consider when attempting to value the company upon transfer of ownership include:

• Market and customers. What is the potential for your company’s growth — is there a market of expertise or specialization to enhance its operations? Do your employees have adequate knowledge of this specialized area, or do they need more resources?
• Infrastructure. What is the quality of your assets, such as real estate and equipment? Do you have adequate management information systems, and is your management team able to maintain your company’s infrastructure?
• Financial performance. What are your company’s earnings, and what is your company’s bank and surety credit without your involvement as a founder?

Maximizing value of the company is the obvious goal of every business owner who looks to sell or transfer their ownership. The value of a construction company can be maximized if the company has four fundamental strengths. The first is a strong financial condition. This includes a healthy balance sheet, strong working capital, minimal line of credit borrowings, positive bank and bonding company relationships, and minimal historical and prospective exposure to sever job losses and contract litigation. The second fundamental strength is a strong backlog. Look at the quality of backlog projects. Does the construction company have the right experience to tackle those projects? Are they within favorable geographical performance zones? It’s also important that the projects in the backlog will yield quality gross profit margins with minimal “booking risk” and “profit erosion risk.” The third fundamental strength is having strong executive and field personnel. It’s critical to invest in seasoned leadership and strong talent. And finally, strong financial systems. Construction companies with proven fiscal controls, established reporting and budgeting systems, and credible and timely financial reporting are seen as more valuable than companies without those systems in place. Financial reporting is also vital to a transitioning construction company as it is imperative the company properly reports its earnings. It is just as crucial that the company report any unusual transactions or financial terms of operations that may impact the intrinsic value of the business. Examples of unusual financial transactions include, but are not limited to:

• one-time construction project gains, losses or other unusual items;
• excess or insufficient salaries or benefits that are paid to owners, family members or executives;
• excess family or executive perks;
• non-market rental or lease arrangements with related parties;
• non-recurring professional fees; and
• non-recorded financial transactions, including contingent gains and losses from construction litigation.

The Surety’s Point of View

Equally important as the overall financial performance of the company, if not more so, is confirmation that the new leadership team has the capabilities and a mindset that is consistent with the previous, successful management team. A surety’s assessment of management capabilities is more art than science, as nearly all sureties recognize that the contractor, rather than the surety underwriter, is the true expert in the construction business. As a result, the surety’s assessment is based primarily on overall comfort with the management team’s attitude towards financial and operational risk; a realistic attitude towards technical capabilities; and consistent transparency and responsible engagement with owners, subcontractors and service providers. Of course, a track record of successful project execution is the foundation of the management assessment. There are several best practices that the sureties will look for when supporting a contractor who is in the process of transitioning the company:

• Full commitment to succession planning – Top companies of all sizes view succession planning as part of their core responsibilities rather than as periodic events. Once top candidates for future leadership roles are identified, the leading contractors spend considerable time developing the capabilities of their high-potential candidates.
• Ongoing evaluation – Rather than identifying candidates for a “just in case” checklist, top organizations assess potential and performance on a continual basis when evaluating the readiness of leadership candidates. Further, rather than relying on performance in an employee’s current role, additional “bolt-on” responsibilities are given to stretch a future leadership candidate and determine his or her ability to operate at the next level. In this regard, a safety net is usually provided in order to limit the tuition cost of the education.
• Transparency – The pros and cons of transparency with succession plans are often debated. Full transparency can lead to the unintended consequence of resentment from less successful leaders, while limited transparency can result in mistrust within the organization. While there are merits to each argument, our observation is that top contractors tend to have a high level of transparency with leadership succession plans within their organizations. In addition to the internal transparency, the top companies also share their plans early and regularly with their service providers to ensure support for future changes.
• Planning with no immediate event on the horizon – Leading companies have made succession planning and leadership development an essential part of their core business activities. This approach results in an “always ready” environment that can make future planned or unplanned succession events less daunting and risky when the time comes.
• Depth of planning – When speaking of succession, we often hear people refer to the top jobs within an organization. Leading contractors go beyond senior management jobs when looking at their succession plans and then commit to an ongoing plan to identify and develop talent for positions that are well below the executive level. Over time, these companies have found that the process ultimately results in an extremely strong commitment to the organization’s success, as staff members feel they are part of a well-developed and strategically aligned plan for future growth and continuity.
• Attracting and retaining talent – Along with providing clear benefits in preparation for eventual management or ownership transitions, embedding succession planning into a contractor’s culture can help attract and retain staff in today’s highly competitive labor market. An absolute priority for attracting new talent is an environment of frequent feedback and well-developed career plans. A strong succession-planning culture facilitates the environment demanded by the new workers entering the workforce and the future leadership pool.

Overall, it is very important to decide what the best course of action is in order to ensure the goals and objectives of the selling shareholders are met. If there is one industry that understands the need for planning, it is construction. Timelines, deadlines and changing conditions are factors that construction leaders deal with on a daily basis. The companies that are strategic, realistic and committed to a successful transition will be the ones positioned for positive results. Remember, you don’t need to execute a plan all at once, but by setting interim goals, you can have a solid plan in place before you’re ready to pass on the business. The sooner you start discussing your succession with those you trust, the sooner you can feel secure about your company’s legacy and your personal future. Top contractors are ahead of the curve in making succession planning part of their core management and leadership activities, and those organizations will be better prepared for when the inevitable decision to transition occurs.   Angelo Straface, CPA, is a Senior Manager at Sax, LLP. He is a member of the firm’s Construction Practice and manages the audit and review engagement teams. He can be reached at astraface@saxllp.com.    " target="_blank">Essentials to Successful Succession Planning & Transfer of Ownership